Rise of COVID in China

closed hanged on door
COVID closing businesses in China

While the world is still transfixed by Ukraine developments, China has reported a significant resurgence in COVID cases. Case loads are still relatively small compared to some other countries. However, the economic effects of anti-COVID measures in China are amplified because of their zero-COVID policy.

Shenzen is already under lockdown. If it spreads, there will certainly be deleterious effects on the Chinese economy and even the global economy. There is no need for major alarm now, but traders need to monitor this closely.

Iron Ore Powers On

Iron Ore Price as of 7 March 2022

Iron ore price has breached 167, almost doubling from Nov 2021 lows in just 4 months. What a ride it has been. The drivers for the outperformance remain the same – supply disruption, expectations of increased demand and uplift from general euphoric commodity sentiment.

At these prices, it is potentially entering bubble territory. It is probably still too early to short it, as the situation is still very fluid. Thus I am just continuing to monitor closely.

Iron Ore Is Blasting Off

Iron Ore Price as of 22020303 @ 158.10

Iron ore prices are rising rapidly, increasing from about 125 (2 weeks ago) to about 158 today. This is fueled by disruption of supply from Ukraine, and perhaps also by general commodity sentiment. Until the disruption is resolved, it would be advisable not to short iron ore stocks. I also would not go long, as prices have already risen significantly. The best course of action is to just continue monitoring news flow and price action.

Markets Brush Off Ukraine Invasion

cosmetics makeup brushes and powder dust explosion
Brushing off the invasion of Ukraine

After initial plunges due to the Ukraine invasion, most markets regained composure. S&P ended 1.5% higher, making a spectacular intraday recovery. Asian markets rebounded somewhat in the morning and early afternoon sessions.

Is the invasion really a totally benign event not affecting the global economy at all? Definitely not. There are several good write-ups on it, such as this article from Financial Times and this from The Economic Times. The global economy would take perhaps a 0.2-0.3% GDP hit over the next few years, but risks have increased, especially with the oil/inflation aspect. The situation is definitely worse due to the invasion, but there is still considerable uncertainty regarding how much worse.

More certainty would arrive as the situation develops further within the next few days, weeks or months. If you are confident of the long-term prospects of your stock, it might be a good buying opportunity. Meanwhile, this is a good chance to practice managing greed and fear. Fear was abundant yesterday, but greed has been in play for much of today. Most of the time, giving in to extreme fear or greed will lead to unprofitable outcomes.

Worst-Case Scenario For Ukraine Is Unfolding

soldier holding gun
Photo by Jakson Martins on Pexels.com

Russia has formally launched a military operation in Ukraine. Dow futures are about 500 points off. Stocks are tanking. Gold and oil prices have spiked upwards. In these situations, it is more important than ever to keep your emotions in check, and avoid impulsive actions.

If you can stay logical, do read up as much as you can on this situation, and monitor news flow closely. It will help you determine what stocks to buy and sell, and also the timing to do so.

Conversely, if you feel that your emotions may cloud your judgment, please do the opposite and stay away from media reports on the markets. Do something to distract yourself. But try not to take too long to return to the markets. Opportunities may present themselves during this volatility that may not last long.

Do remember that in addition to asset prices fluctuations, there will also be some changes in stock/industry fundamentals. Thus it will be prudent to revisit the investment/trading cases for the stocks you already have or are interested in acquiring.

Good luck and stay sane!

How Retail Investors Can Compete Against Institutional Investors

Retail Investor vs Institutional Investor

Retail investors are always seen as the perennial underdogs against institutional investors. Indeed, institutional investors have significant advantages over the average man in the street. However, retail investors can still be successful and perform well in the markets, given the right knowledge and frame of mind.

What are Retail Investors Up Against?

Institutional investors are people employed by companies/organizations to make trades in the markets. These organizations include banks, insurance companies, mutual funds and hedge funds. With their large budgets, economies of scale and corporate connections, they are able to:

  • Obtain faster, more in-depth info
    • fundamental research in companies, sectors, economic trends
    • price-moving events in real-time
    • alternative economic indicators (eg. satellite images, railway traffic)
  • Invest in the best hardware and software
  • Trade more cheaply
    • their large volumes allow them to command lower fees
  • Hire good traders/investors with proven track records
  • Provide expensive/specialized training

Why Retail Investors Still Can Compete

There are several reasons why retail investors should still be able to compete with institutional investors despite their huge advantages listed above:

  • Complexity of the Markets
  • Size and Variety of Markets
  • Constraints of Institutional Investors
  • Agility and Flexibility of Retail Investors

Complexity of Markets

The markets are made of many moving parts. Many variables affect the price of assets, some are difficult to quantify while others may not even have an obvious relation to an asset. This underscores the difficulty of predicting asset price movements.

Major financial institutions have many years in the industry, and also possess some of the best talents. And yet they get their target prices for stocks wrong more often than they get it right. Since no one can very accurately predict stock prices, no one can dominate, and hence everyone in the game still has a chance.

Size and Variety of Markets

There are many asset classes in many markets, spread across many sectors and occupying different niches in their locale. New assets are being created everyday, adding to the colour and diversity of the markets.

With such a huge number of possible assets to trade or invest in, there would always be some which are not traded by institutional investors yet. Also, retail investors may be able to explore and find a niche in which they are familiar with and have an edge.

Constraints of Institutional Investors

Institutional investors invest/trade in huge amounts. This means that companies with small market capitalizations and those with low liquidity are not appropriate candidates for them.

They are also often not able to buy or sell stocks at one go, as their orders may fill up the current price level and slip into the next price level(s). They may need to split up into several different orders, sometimes across different days.

There may be mandates from management preventing them from investing in the stocks they prefer, for example ESG mandates. They may also need to buy an asset which they may not particularly like, perhaps for maintaining fund composition requirements.

Agility and Flexibility of Retail Investors

Retail investors deal in small amounts. They are able to invest in small cap and illiquid stocks. Their orders can be filled easily within the current price level, thus they have no problems buying/selling quickly.

They also do not have any constraints on the type of investments to make (eg. ESG mandates, fund composition). Also, there is no need to force a trade/sale if there are no good options around, they can wait until an opportunity arises.

What Retail Investors Can Do To Compete With Institutional Investors

Retail investors should aim to minimize the advantages institutional investors have over them, and maximize their own advantages over them.

  • Research to reduce information gap
  • Explore freely to find areas you perform well in
  • Be patient and do not force trades
  • Be nimble and react to fundamental changes quickly

Research to Reduce information gap

With the advent of the Internet, retail investors can now access a lot of information for free. They can diligently research on the stocks and sectors of interest to keep themselves updated. It is also useful for getting near real-time updates for time-sensitive trades.

Free information sources can probably give you about 60 to 70 percent of the info that institutional investors receive. To gain more specialized information, retail investors can subscribe to dedicated financial sites. Sometimes, this is necessary in order to gain more knowledge in depth in certain areas, and increase your chances of developing a trading/investing edge.

Explore freely to find areas you perform well in

Retail investors are free to try out any trading techniques and strategies in any areas of the market, without needing to seek permission and report results. They should keep learning about new assets and instruments, and not be afraid to try them out.

Be patient and do not force trades

Being able to wait for a while for a good trade will guarantee a higher probability of success than being forced to make suboptimal trades. Retail investors have the luxury of not making trades for weeks, months or even sometimes years. They should take advantage of this privilege to make fewer but higher quality trades. This will lead to a higher percentage of winning investments.

Be nimble and react to fundamental changes quickly

Retail investors can enter and exit a position easily in just 1 or 2 trades most of the time. Institutional investors trade in large sizes, and have to enter or exit a position gradually over time. This is to ensure that their trades do not cause prices to shift and cause them to transact at unfavourable prices.

This means that retail investors are a lot more agile, and can establish or exit a position much quicker, most often on the same day. In contrast, an institutional investor owning perhaps 10% to 15% of the entire company has to take some time to entirely dispose of a position.

Retail investors should regularly monitor news flow, and react decisively on any fundamental-altering event once some research has been done to ratify its legitimacy and impact. For example, if a major coal-using country decides to ban coal imports and make a major push towards natural gas and renewables, it would be optimal to cut positions in coal miners as soon as possible.

Conclusion

As of current market conditions, retail investors still have a good chance of doing well in the markets against the institutional investors. They just need to choose their battles well and be willing to put in time and effort to hone their edge.

This may change in the future, depending on how the nature of the markets changes and how unequally technology advancements benefit retailers/institutions. However, no one can predict the future accurately, so there is no need for retail investors to worry about it at the moment. The sun is still bright for them, so they can focus on making hay while the sun shines.

How To Develop and Maintain Your Trading Edge

silver and gold switchblade on gray and white surface
Your Edge

What is a Trading Edge

A trading edge is an aspect/area of trading in which you are better than most others at, and which allows you to profit consistently from trading. It may not necessarily encompass merely a specific technique or fixed set of techniques, but may also include the approaches adopted to handle the technical, strategic and mental aspects of trading.

Most of this article is relevant to investing edge as well. There is a fine line between investing and trading, and sometimes the boundaries are blurred and overlapping.

Why do you need a Trading Edge

Without a trading edge, it would be difficult to make enough money from trading to make a difference in your life. This is because trading is a negative sum game – the players have a less than 50% chance of profits on average because of the fees imposed by the various middlemen (eg. transaction fees, holding fees, trading platforms, stock exchanges, financial institutions). Thus if you are an merely average player in this game, you have a less than 50% chance of making consistent profits.

Arguably, if you are trading/investing over the long term, the game becomes a positive sum game, where the average player has a more than 50% chance of profits. This is because of the effects of technological progress and efficiency gains in companies over time. However, you are unlikely to make life-changing amounts simply by banking on these effects.

How do you develop a trading edge?

There are 4 things you need to work on concurrently.

  1. Understand what drives asset prices
  2. Understand the methods to trade the markets
  3. Experiment to find out what works for you
  4. Work on honing your cognitive skills

1. Understand what drives asset prices

Understand how markets work and what makes stock/asset prices go up or down. A lot of information is already on mainstream media free, so a reasonable understanding can be obtained from websites and videos.

Do note that you would need to regularly measure a pulse of the markets by constant research, as market behavior changes constantly.

2. understand the methods to trade the markets

There are various instruments available to trade markets, for example regular stock purchasing, options, CFDs, Daily Leverage Certificates. And there are various ways to utilize them, either within themselves or in combination with each other. The characteristics of each method should be studied, for example one-time costs, holding costs, leverage, break-even point etc. In addition, it would also be good to know the expected pattern of results of each method (eg. buying options typically results in more losses of smaller amounts, but also wins of greater amounts).

An example of an analysis of trading methods can be found in my previous post here.

3. Experiment to find out what works for you

Basically, be like a mad scientist and try out many different ideas. Test out different instruments using different strategies across different asset classes. But please do it without bankrupting yourself in the process. Use demo accounts first, but if you find demo experience not useful at all, go with live accounts, but trade with small amounts first.

4. Work on honing your cognitive skills

Your cognitive skills are used to assimilate info, develop strategies, recognize patterns and trends, identify correlations and learn from experiences. With more honed cognitive abilities, you would have a higher chance finding an edge, and your edge would be sharper.

There are many ways to improve cognitive abilities. There is a good article on it here. Personally, I find that computer games involving problem-solving and monitoring/managing different data points are useful in this aspect.

How Long Will It Take To Develop A Trading Edge?

Like any other skill, it will take a lot of time and effort. You may have heard of the “10,000 hours rule” to master a skill. The truth is, there are a lot of variables affecting learning speed, and not everybody will take the same time to develop an edge. Some may take months, while others may take years.

Will I be able to Develop A Trading Edge By Copying A System/Approach Already Used By Other Traders?

It is unlikely for 2 reasons:

  • Your trading edge likely has to be customized for your own cognitive and personality traits
  • If a system/approach has been copied and used widely, it likely would lose its competitive advantage

It can still be useful to look at other successful systems/approaches. You can adapt parts of them to fit into your strategy.

How Long Will Your Trading Edge Last?

It really depends on how markets evolve and the nature of your trading edge. They can last for less than a year, or they can be effective even after many years. Markets do evolve, and it is unlikely that any trading edge can last forever. You can try to maintain its effectiveness over time by continually tweaking it to cater for changing market behavior. If tweaking does not work anymore, it would be wise to move on to find another trading edge.

Conclusion

Being able to develop and maintain trading edges is key to being a successful trader. It will definitely take a lot of work, but the end result will be worth it.

When you have developed your edge, it is important to stay humble and recognize that market dynamics can change anytime and render your edge useless. Conversely, if you have not yet developed your edge, just keep learning and trying different things, your breakthrough may yet come soon.

Good luck!

Iron Ore Surges Further

Iron Ore Price as of 1 Feb 2022

Since my last post 2 weeks ago, the price of iron ore has surged further from about $124 to as high as $148. It is currently at about $137. The surge is all based on hope that demand will improve, fundamentals have not improved at all.

China has just stated its intention to suppress the iron ore speculators driving up prices. Could this be the start of a sentiment shift? It is possible, though there may not be a straight one-way journey down. China did the same thing last year, and prices went down, back up and then down again. In my opinion, the fundamentals of supply and demand will matter most in the end. Thus it is best to monitor news flow pertaining to them, in order to gain clues on medium to long term price direction.

If you are itching to trade iron ore equities, in my opinion the downside risk-reward ratio is more attractive than the upside. Do note that this week the Chinese are on holiday, so the number of traders is smaller, which would imply greater unpredictability of the price action.

Emotional Cost of Trading/Investing

woman holding her head
Stressed by Losses

We all know that making a trade is not free – it costs money (transaction, holding costs) and time (research, analysis, trade execution). But less commonly mentioned is that trading/investing also incurs emotional costs. Stresses are incurred in almost every trade, and it is important to take this into account in order to maximize the probability of success for your trading/investing strategy.

The market has been in chaos during the past week (as of the time this article has been written). Equity and crypto markets have dropped sharply, with some assets down as much as 50%. This is most likely the most stressful period for traders and investors since the Covid crash of March/April 2020. It is periods like this that the emotional costs of trading/investing become most significant, and hence most important to manage.

What is Emotional Cost

Emotional cost of trading/investing is the collective set of negative emotions one experiences during trading/investing which causes psychological stress and may potentially lead to emotional exhaustion.

Why It Is Impossible To Avoid Incurring Emotional Costs During Trading

Emotional costs are incurred whenever a non-optimal trading/investment decision is made, as regrets are experienced for every buy or sell trade which did not result in the most money made or least money lost. It is nearly impossible to consistently make optimal decisions in trading, as trading is too complex. To make a trade in general, one has to decide on 3 things:

  • Direction of trade (Should I go long or short?)
  • Timing of trade (When should I make the trade?)
  • Quantity of trade (How much money should I put into the trade?)

It is literally impossible to consistently buy/sell at the absolute lowest/highest points using 100% of your buying/selling power. It is not necessary to do that in order to be profitable, but even when you have made a profitable trade, you would have some regrets over the decisions you could have made to make even greater profits. Indeed, there would be regrets in most trading situations.

For example, the regrets after a trade has been initiated are:

Price went down after trade initiationPrice went up after trade initiation
Shorted using 100% of selling powerNo regretsShould not have shorted
Shorted using < 100% of selling powerShould have increased position sizeShould not have shorted
Didn’t initiate tradeShould have shortedShould have longed
Bought using < 100% of buying powerShould not have boughtShould have increased position size
Bought using 100% of buying powerShould have boughtNo regrets
Table of Regrets

In most situations, regrets would surface. And it is unfortunate but true that the negative emotions aroused by bad trades are stronger than the positive emotions evoked by good trades. Thus overall, an investor/trader would likely experience net negative emotions from trading/investing.

Impact of Excessive Emotional Costs

Firstly, it impacts your trading/investment performance. Staying disciplined and sticking to your trading strategy is difficult when you are facing massive losses. Huge losing positions may be liquidated, even if they should be held due to fundamental/technical reasons. And worse, subsequent risky trades may be undertaken to try to recover losses, even if the risk/reward ratios are not favourable.

Secondly, it affects your mental well-being and may blunt cognitive capabilities. This would lower success rates significantly.

Lastly, there may be detrimental effects on the non-trading/investing aspects of your life. Your personal and professional life may suffer, perhaps permanently and significantly.

How Should You Manage Emotional Costs

The best way to manage emotional costs of trading/investing is to simply take them into account when deciding to make a trade. This should be done at both the individual trade position and entire portfolio level.

individual position level

  • Max Loss
    • Determine the lowest price your stock/asset would go to (or highest price, if you are making a short trade)
    • Calculate the amount you would lose at the lowest point
    • Decide if you can take the loss for that trade/investment position
  • Daily Volatility
    • Estimate the daily fluctuations in value of the position you are considering to take
    • Decide if you can withstand the daily fluctuation in your position value

Portfolio Level

  • Max Loss
    • Estimate the losses your portfolio would take in the event of a worst-case market development
    • Add the max loss of the position you are considering to take to your estimated max portfolio loss
    • Decided if you can take the max loss for your entire portfolio
  • Daily Volatility
    • Estimate the daily fluctuations in value of the position you are considering to take
    • Add the estimated daily fluctuation in value of the position under consideration
    • Decide if you can withstand the daily fluctuation in value of your portfolio

Conclusion

The emotional aspect of trading/investing is generally under-appreciated in mainstream educational media. More coverage is placed on how to execute wining strategies and choose winning stocks. When positions are small, emotional costing may not be so significant, but it needs to be considered as soon as you start to increase position sizes. This would ensure that trading discipline can be maintained and cognitive performance is not degraded, and hence success rates can be maintained.

China Begins To Ease Financial Conditions

man turning on vintage boombox placed on red car
China Starting To Adjust Financial Policies

China has started the easing of financial policies in order to combat a slowdown in economy growth. On Monday, it cut borrowing costs of its medium-term loans. Bond yields fell as bonds became more attractive. Today, it has made more cuts to various lending rates. These moves are intended to increase borrowing by firms and stimulate the Chinese economy.

This could be the start of a period of sustained policy easing, which would stabilize market sentiment for Chinese-related stocks and make it a good entry point for beaten-down stocks. Indeed, HK property and tech stocks have soared. But no one really knows how much policy easing will occur and in what form, as China remains concerned about having too much debt.

This is not an all-clear signal to buy any Chinese-related stock, there still needs to careful select of sectors and stocks which are most likely to take advantage of the stimulus. Do take control of any greed creeping in, catching falling knives is really enticing but some knives may drop further.